Today, most of us carry around a smartphone that offers a multitude of functionality in one device. Just as the smartphone was a runaway hit for the telecommunications industry, a similarly exciting growth story is unfolding in the life insurance industry with indexed universal life insurance.
The market for indexed universal life (IUL) insurance has grown from a $330 million market in 2006 to a $1.5 billion market in 2012, and sales of IUL products increased by 36 percent from 2011 to 2012.1 By offering a range of benefits packaged neatly in one product, insurers have hit upon a solution that is changing the way life insurance is bought and sold. In short, IUL is revolutionizing the life insurance industry, much as the smartphone has transformed the telecommunications industry.
A Better Mousetrap
With IUL, our industry may have built a better mousetrap. By offering a death benefit and tax-deferred cash accumulation with more growth potential than traditional conservative financial products and less risk (though less upside potential) than variable universal life insurance, IUL addresses many of the needs and concerns that consumers are wrestling with today. That includes stock market uncertainty, low interest rates, concerns about taxes and worries about outliving their retirement dollars.
When Genworth conducted research in 2012 among agents and their staff to better understand which features of IUL resonate most with their clients, we discovered that producers are most excited about three major advantages:
• Flexibility to meet a number of different needs in a single product.
• Greater cash accumulation growth potential with downside protection.
• Tax-efficient solutions.
Let’s look at each of these potential benefits individually.
Flexibility. IUL combines death benefit protection with the potential for cash accumulation that can be used for just about any purpose, including funding education costs and medical expenses. Some IUL policies also offer an optional accelerated benefit rider for long term care services.
More Growth Potential/Less Downside Risk. Prolonged low interest rates and market volatility continue to challenge cash accumulation opportunities, which is particularly worrisome for consumers who are retired or nearing retirement. Only 32 percent of Americans currently in the work force believe they have sufficient assets to retire.2
IUL offers the potential for greater growth than many traditional conservative options such as CDs and money market accounts by linking interest crediting to an index such as the S&P 500. At the same time, an IUL policy contains a “floor” that protects any principal and accumulated cash from downturns in the market. When the actual percentage change of the index drops below the floor, the client simply does not receive any interest, unlike a variable universal life policy where the policyowner selects the underlying investments and bears all of the investment risk with no downside protection.
The beauty of IUL products is that if the market drops around 40 percent (like it did in 2008), clients would not lose a penny of their principal and accumulated interest. They would merely receive zero interest in that year. In other words, the market does not have to get back to where it was before clients experience growth—which is clearly different from a variable universal life insurance policy. For future retirees who have been shaken by earlier market turbulence, this protection can be immensely reassuring.
The flip side, of course, is if the market goes up 40 percent, owners of variable universal life insurance policies would experience the entire gain, while the IUL policyowners would have their interest capped.
Tax-Efficient Solutions. The inherent income tax advantages of life insurance make IUL a worthy complement to term life insurance, IRAs, 401(k) plans, and other components of a client’s financial strategy. With a death benefit that is generally federal income tax-free, the potential to accumulate cash on a tax-deferred basis and tax-free supplemental income for retirement, education costs or other purposes, IUL may be just the ticket. There are not many financial products available today that allow a policyholder to put in after-tax money, grow the money tax deferred, then take federal income tax-free3 distributions. I call this “paying taxes on the seed versus the harvest.”
Such a product can also be appropriate for business owners looking to fund buy/sell agreements, deferred compensation, key person arrangements or supplemental retirement income.
The Ideal Candidate
As part of our research, we asked producers already selling IUL to describe the ideal candidate for this type of insurance. In a nutshell, they said typical candidates are between the ages of 40 and 59, earning from $100,000 to $250,000. They are purchasing IUL insurance for their own use, have liquid assets between $100,000 and $500,000 and have a moderate risk tolerance.4
That’s not to say that an IUL would not fit a client who did not meet these parameters, but a client who has the liquid assets and the earnings listed above may be in a more favorable position to benefit from having such a policy.
For example, consider a potential client who is 40 years old and earns $150,000 a year. He is unhappy with both his current life insurance coverage and his retirement savings and wants to expand each. Yet he is also keen to have a great degree of flexibility—he’d like to access his savings prior to retirement without triggering federal income tax penalties, and he’s also wary of market downturns.
Say the client has put aside $500 a month to achieve all of these goals. This is a tough order to fill if the client allocates that sum to a low-interest-rate product like a money market account, which could provide disappointing returns, or if he buys a variable universal life insurance policy, which could expose him to market-related losses.
By contrast, an IUL policy may be ideally suited to his needs. The $500 a month would pay the planned premium for a policy that would provide the client’s beneficiaries with a generally income tax-free death benefit, helping to fill any gaps with his current life insurance policy. At the same time, he would have a policy with index-linked interest crediting, potentially providing more growth potential and he could access his cash value on a federal income tax-free5 basis before or during retirement.
Through our research, we found that agents are very optimistic about the sales potential of these products. In fact, those currently selling IUL expect their total sales of this product to increase by 35 percent in the next five years.
An IUL policy can answer a set of what may seem like multiple, contradictory needs and concerns from a client. These policies work on both ends of a client’s needs spectrum: They provide a death benefit and assurance as well as offer the potential for interest growth and the flexibility needed to handle life’s unexpected demands.
Given prolonged low interest rates, now is a great time to speak with your clients about IUL.
If your clients do purchase an IUL policy, it’s important for you to monitor their chosen policy to make sure it is on track to help achieve their goals. That means meeting annually with them for a policy review, including current levels of premiums and index crediting strategies.
Certainly no single insurance policy will fulfill all of your clients’ needs. However, having an IUL policy as part of a prudent and diversified retirement strategy can go a long way toward stabilizing your clients’ retirement plans and giving them a sense of security in an uncertain time.
All guarantees are based on the claims-paying ability of the issuing insurance company.
1. U.S. Individual Life Insurance Sales, Fourth Quarter 2012, LIMRA.
2. Genworth Retirement Income Consumer Study, August 2012.
3. A withdrawal may be free of federal income tax or “tax free.” If the policy is not a modified endowment contract (MEC), then withdrawals are not taxable to the extent that they do not exceed basis, except for certain changes in the policy during the first 15 policy years and especially during the first five policy years that cause cash distributions that may be taxable even if they do not exceed investment in the contract (basis). Policy loans are free of federal income tax when taken except if the policy is or becomes a MEC.
If the policy is a MEC, a distribution (withdrawal or policy loan, including any increase in the policy loan balance because of unpaid loan interest) is taxable to the extent that policy value exceeds basis. A 10 percent penalty tax may apply to distributions from a MEC if the policyholder is under age 591/2.
Basis is premium paid minus any long term care rider charges and minus nontaxable amounts previously recovered through policy distributions. Assignment or pledge of a MEC as security for a loan would also be a taxable event. If the policy becomes a MEC, then any distribution (withdrawal or policy loan) taken in the policy year in which the policy becomes a MEC and in subsequent policy years is taxable the same as a distribution from a MEC. Any distribution taken within two years prior to the policy becoming a MEC may also be taxable the same as a MEC. Termination, other than by reason of the insured’s death, of a life insurance policy with a policy loan balance may be deemed a distribution of the outstanding policy loan balance, resulting in possible adverse tax consequences for a policy that is not a MEC. Consult a tax advisor about possible tax consequences. We are not responsible for any adverse tax consequences.
4. Genworth IUL Research, 2011-2012.
5. See footnote 3.